Corporate Managers, Agency Costs and the Rise of Double Taxation

Abstract:     
The double taxation of corporate income is routinely criticized, but its origins have never been adequately explained. This Article traces the rise of double taxation to the problem of agency costs, or those costs flowing from the delegation of control to an agent - the professional manager - who is imbued with self-interest. Originally, shareholders acceded to managers' decision to retain upwards of 50% of corporate income because it would be taxed at a lower rate at the corporate level than it would be if distributed and subject to the high individual surtax rates (although it was exempt from the normal tax). In 1936, however, President Roosevelt pushed through a tax on undistributed profits that threatened to upset this arrangement. Business leaders hoped that subjecting distributed corporate income to full double taxation would aid in realigning management-shareholder attitudes toward the retention of corporate earnings. While others have connected the persistence of double taxation to the problem of agency costs, this Article is the first to establish that double taxation arose as a political resolution to the problem of divergent manager/shareholder views toward dividend payout policies.

Working Paper Series